A study on financial health of cement industry

— “Z” score analysis

The Indian cement industry is one of the pillar sectors

of our economy as it accounts for a significant portion
of total industrial output of our country. Further it plays
a dominant role in satisfying basic needs (house
construction) of human kind. In view of LPG, while
India Cements Industry faces many challenges, it gets
good opportunities to improve sales. As a result of this,
Cement Industry continues to adopt a series of
readjusting and restructuring measures including up
gradation of technology. India is largest market with
a great potenial, as the country possesses more than a
billion people, vast territory and abundant resources.
The cement industry can enlarge global market shares
so long as the industry players firmly seize the business
opportunities, promptly solve outstanding problems and
improve weak links in their existing production chain.
The industry is expected to perform well in all the
dimensions and achieve a healthy growth in its
operations. In order to manage stiff competition, drastic
steps are to be taken to reduce cost of production. In the
changed environment, application of financial
management techniques would help the cement
companies in increasing their productivity and
profitability. An 1. To examine the overall financial
performance of India Cements Ltd, and 2. To predict
the financial health and viability of the India Cements
Ltd.

Methodology of the Study

Application of Z Score
"Z" score analysis has beenestablished by Edward I.
Altman (1968) to evaluate the general trend in the
financial health of an enterprise over a period. Many of
the individual accounting ratios used frequently to
predict the financial performance of an enterprise may
only provide warnings when it is too late to take a
corrective action. Further single ratio does not
convey much of the sense. There is no internationally
accepted standard for financial ratios against which the
results can be compared. Therefore, Edwin I Altman
combined a number of accounting ratios (liquidity,
leverage, activity and profitability) to form an index of
the probability, which was effective indicator of
corporate performance in predicting bankruptcy.
In this direction a variety of studies have been
conducted, over the period by applying Multiple
Discriminant Analysis (MDA) to predict the corporate
failure, by financial analysts like Altman.

Data Collection
The study is concerned with the analysis of financial
health of India Cements Ltd and it has been confined
attempt has been made in the present study to have an
insight into the examination of financial health of the
one of cement companies in Tamil Nadu.
History of India Cements Ltd.
The India Cements Limited, established on 21.2.1946
under Indian Companies Act 1913 as a public limited
companies with an authorized capital of Rs.200 lakh is
having its registered office at Dhun building, 827, Anna
Salai, Chennai-600 002. It is to manufacture and market
cement. It is the largest manufacturer of cement in south
India and earliest cement company in independent
India. The equity shares of the company are listed in
NSE, BSE CSE,LSE and MSE.

Statement of the Problem

Cement industry represents an important segment of the
Indian economy. This industry has been caught in a
vicious down cycle that has rendered operations
unviable. Some of the Cement producing companies has
recently reported reduction in profits and in some cases
even losses. The India Cements Ltd incurred losses in
2002. One possible reason for such down cycle might
be poor financial health. Since the cement producing
companies face threats to their viability, this study bears
a relevance to the present day problems.

Objectives of the Study

The objectives of this study are as follows. They are:
A case study to predict financial health of India
Cements Ltd using 'Z' score
Case Study
to only one company in the private sector. This study is
mainly based on secondary data. The data from
published sources is the basis for ratio analysis. The
required accounting information about India Cements
Ltd for the Z- score analysis was obtained from the
Prowess Corporate Data Base of CMIE, Chennai for a
period of 5 years (1998-2002).

Z Score Analysis
The data collected were first analysed with the help of
five accounting ratios. These different ratios are
combined into a single measure-Z Score Analysis with
the help of MDA. The fonnula used to evaluate the
"Z"score analysis as established by Altman is as
follows.
Z = 0.012X1 + 0.014X2 + 0.033X3 +
0.006X4 + 0.999X5
" Z" is the overall index and the variables X1 to X4 are
computed as absolute percentage values while X5 is
computed in number of times.

Variables (Ratios) Used in Z Score

Analysis.
The following accounting ratios are used as variables to
combine them into a single measure (index), which is
efficient in predicting bankruptcy.
X1 -The ratio of working capital to
total assets (WC/TA*100). It is the measure of the net
liquid assets of a concern to the total capitalization.
X2 -The ratio of net operating profit to net sales
(NOP/S*100). It indicates the efficiency of the
management in manufacturing, sales, administration
and other activities.
X3 -The ratio of earning before interest and taxes to
total assets (EBIT/ TA*100). It is a measure of
productivity of assets employed in an enterprise. The
ultimate existence of an enterprise is based on the
earning power (profitability).
X4 -The ratio of market value of equity to book value
of debt (MVE/ BVD *100). It is reciprocal of the
familiar debt-equity ratio. Equity is measured by the
combined market value of all shares, while debt
includes both current and long term liabilities. This
measure shows how much assets of an enterprise can
decline in value before the liabilities exceed the assets
and the concern becomes insolvent.
X5 -The ratio of sales to total assets (S/TA). The capital
turnover ratio is a standard financial measure for
illustrating the sales generating capacity of the assets.

Measurement of Financial Health

Altman established the following guidelines to be used
to classify firms as either financially sound or bankrupt.
Altman Guidelines for Healthy Zone.

Situation- Z scores Zones

I below 1.8 Bankruptecy Certain Z o n e to fall
II 1.8 - 3 . 0 H e a l t h y Uncer- Z o n e tain to Predict
III 3.0 and Too Healthy Not to above Z o n e fall
1. Below "Z" score of 1.8, the unit is considered to be in
bankruptcy zone. Its failure is certain and extremely
likely and would occur probably within a period of two
years.
2. If a unit has a "Z" score between 1.8, and 3, its
financial viability is considered to be healthy. The
failure in this situation is uncertain to predict.
3. Above "Z" score of 3, the unit is in too healthy zone.
Its financial health is very viable and not to fall.

Financial Health of India Cements Ltd

-Ratio Analysis.
The five financial ratios cited above are used as
indicators in the equation for judging the financial
health of India Cement Ltd. Table-l shows the select
ratios (variables ) of India Cements Ltd during the
period from 1998-2002. The content of working capital
in the total assets of India Cements Ltd was
increased from 28.14% in 1998 to 86.43% in 2002 with
fluctuations. It showed the excessive use of working
capital over the years. This is unfavourable for the
efficient running of the India Cements Ltd and it affects
financial health. It is found from the above Table
that the content of net operating profit to the total assets
was recorded as 10.64% in 1998 which decreased to -
3.26% in 2002 with fluctuations. During first four years
of study period (1998-2001) company earned profit. But
it suffered with net loss in 2002. This is a worse
situation for shareholders as no portion of sales was left
for them in 2002. In total, the company failed to
earn adequate surplus to meet nonoperating activities in
2002.
The operational efficiency of an enterprise could be
judged through the ratio of EBIT/Total Assets. The
operating efficiency ultimately leads to its success. The
ratio of EBIT to Total Assets of India Cements Ltd
ranges from 13.22% to 9.82%. Though there
was an increase in the amount of EBIT and total assets
as well, ratio got decreased marginally. It showed that
increase of EBIT did not match with an increase of total
assets. This has severely and adversely affected the
financial health of India Cements Ltd. The thumb rule
of debt- equity mix is 1:1. The analysis of this study
cleared that India Cements Ltd did not maintain the
above standard during the study period. The market
value of equity was less than that of debt during
the study period. As a result the ratio of market value of
total equity to book value of debenture was 15.22% in
1998, which constantly decreased to 11.39% in 2002. It
means book value of debenture of India Cements Ltd
ranged from 84.78% to 88.61% during the study period.
The proportion in which interest bearing funds (debt)
and interest free funds (equity) employed
had a direct impact on its financial performance. Even if
borrowed funds have been 50%, the financial position

Case Study
of the company would be considered as quite good.
From this angle, the company has a sound financial
position. However, the company will have the chance of
facing interest burden in the long run. Therefore,
reasonable change in the financial structure ratio is
essential to protect the company from adverse financial
performance. Table also shows that the sales in relation
to total assets had been around 0.536 to 0.4095 times
during the study period. Sales is the central point
around which all the operations moved. The financial
performance and profitability depends on sales revenue.
Generally this ratio is expected to be two times. The
results of sales volume during the study period clearly
showed that the cement company had not been
successful in achieving the standard ratio through sales.
Poor ratio of turnover indicates that the company failed
to fully use the assets like land, building, furniture,
plant etc. There may be some valid reasons for under
utilization of available capacity. However, this will
have an adverse impact on the financial performance of
the company. Hence appropriate steps are to be taken to
utilize the full capacity of the company.

Financial Health -"Z" Score Analysis

As pointed out earlier, the "Z" score analysis was
applied to evaluate the general trend in the financial
health of India Cements Ltd by using ratio analysis. The
analysis depends on ratio criteria.
It is clear from the analysis of Table-2 & Chart-l that
the cement company under the study was just on the
range of financial collapse. The financial health of the
company was never in the too health zone during the
study period. However Z score in 2002 rose to healthy
zone while the score for first four of study period
(1998-2001) had fallen in bankruptcy zone. In total the
financial performance of India Cements was very
unviable. If India Cements fails to take urgent steps,
total failure of the company was inevitable and certain
in the near future.

Reasons for the Poor Financial Health

The following are important reasons for poor financial
health of India Cements Ltd.
• the company faced the problem of under trading
owing to the excess working capital
• the negative operating profit/small portion of profit
during the study period was a serious concern. It was
partly because of the fact that earnings were eaten by
excess working capital during the study period.
• the company failed to achieve the sales
targets/adequate sales. This was due to under utilization
of available capacity, which contributed
for the deterioration of financial health.
• excess debt was a serious concern as it carries with
interest burden. This also affected financial health.
• some type of managerial incompetence might have
been accounted for almost all failure.

Suggestions of the Study.

In the light of above study, the following important
suggestions are made to improve financial health of
India Cements Ltd.
• The problem of under trading must be attended to
immediately. Further the company should plan to have
adequate working capital.
• The avoidance of excess working capital may help to
improve operating profit.
• The company must fix achievable sales target and all
possible steps are to be taken to achieve the sales
targets. The deviation from the target must be attended
to.
• The company should take necessary steps to fully
utilize the available capacity. The fixed assets are to be
purchased only when the company is able to utilize its
full capacity.
• The capital structure of India Cements Ltd is to be
changed in such way to have standard debtequity ratio.
Higher debt content affects the borrowing power and
profitability of the concern.
• Necessary arrangements should be taken to improve
the managerial competence of India Cements Ltd.

Conclusion
The financial health plays a significant role in the
successful functioning of a firm. Poor financial health
threatens very survival and leads to business failure.
Most of the cement producing companies in India has
been caught in a vicious down cycle facing a threat to
their viability. Therefore, financial health of cement
companies has been subject to empirical investigation.
In this study an attempt has been made to determine the
combined effect of various financial ratios with the help
of MDA. The estimated discriminate function could be
of great use for the management in ascertaining the
financial health. This study would also be useful to all
companies, policy makers and researchers for
appraising financial health of corporate sector in
general and cement companies in particular.

Reference.
1. Altman.I.Edward. "Financial Ratios, Discriminant
Analysis and Prediction of Corporate Bankruptcy".
Journal of Finance. Vol.9. PP.589-609. 1968.
2. Pandey.I.M.(1979). Financial manage-ment. Vikas
Publishing House, New Delhi.
3. Prasanna Chandra.(1995). Financial Management:
Theory and Practice. 3rd ed. Tata McGraw Hill, New
Delhi.
4. R.K Sahu. "A Simplified Model for Liquidity
Analysis of Paper Companies". The Management
Accountant. Nov 2002. Vol.37, No.11. PP .805-808.
5. Mansur.A.Mulla. "Use of Z Score Analysis for
Evaluation of Financial Health of Textile Mills- A Case
Study". Abhigyan. Vol.XIX. No.4. Jan-March
2002. PP.37-41.